Lowered Expectations: Legg Mason, AMG Downgraded

Shares of asset management firms Legg Mason (LM) and Affiliated Managers Group (AMG) took a hit Wednesday after Credit Suisse downgraded both stocks to Neutral from Outperform.

Legg Mason has fallen more than 1.2% to about $41 and Affiliated Managers Group has declined by 0.6% to roughly $202.

Following U.S. corporate tax reform and quarterly remarks, Credit Suisse analyst Craig Siegenthaler raised 2018 and 2019 earnings per share estimates for both companies, boosting his 12-mo. price target for both stocks. His target for Legg Mason is $49 and for Affiliated Managers Group, $220. However, those changes imply a total return of 15% for Legg Mason, which is higher than peers, but still lower than other Outperform-rated stocks. As for Affiliated Managers Group, Siegenthaler's estimates peg total return of just 8% this year, which is in-line with the peer group average of 5%-to-10%.

Photo: MARIANA SUAREZ/AFP/Getty Images

In March 2016, Siegenthaler upgraded Legg Mason on the premise that the company would meet objectives including net flow recovery, improving EPS visibility, and reduced risk from mergers and acquisitions on new deals. "We now believe our objectives have been mostly achieved and most of the overhangs removed. We also now think our current LM thesis is not significantly differentiated from the consensus," the Credit Suisse analyst explained in a note published Wednesday morning.

Leverage remains a key risk and if the stock markets suffer a sharp pullback, says Siegenthaler. The company could slow down or halt share buybacks to avoid triggering its debt obligations if earnings decline, and "significant buyback activity" has been modeled into Siegenthaler's forward EPS estimates. Legg Mason CEO Joseph Sullivan too reportedly warned of a "disruptive" period for the asset management industry, citing margin compression.

Too much depends on profit growth.

Affiliated Managers Group's organic growth rate has been low and will now largely depend on "low quality drivers," Siegenthaler says. "Furthermore, if revenue growth is driven mostly be beta, we estimate its profit growth is more risky."

The analyst expects alternative asset management firms to outperform in 2018 as C-Corp conversions catalyze valuation ratings. Potential for conversion is highest for Ares Management (ARES) and KKR (KKR). Both stocks are in the green so far Wednesday.

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